It's all in the plan

The IRC Sec. 408 states that if the arrangement (THE PLAN) permits, the owner of an IRA may direct the investment of the assets in his IRA account. Section 408 has a prohibition against investment in life insurance contracts and certain collectibles. That's it. There appears to be no other limits on permissible investments beyond those two restrictions.

While the code allows for almost unlimited choice of investment vehicles, try and tell this to the administrator who has your account now. When establishing or transferring an IRA account, the individual needs to find a plan document that allows the IRA to invest in the types of investments that the individual wishes.

Who has the plans?

There are general plans that are approved by the Internal Revenue Service. Each trustee/custodian makes changes to the plan to suit their needs. The trustees and custodians then end up with a plan that allows them to invest IRA funds in the areas they wish to administrate. The same entity may serve as both the plan administrator and the trustee/custodian.

When the bank tells you, "You can't do that," it really means, "You can't do that here." Just as the stock brokerage company may limit investment to certain funds, a bank's plan may restrict the IRA from investing in real estate. What you need to do is find another plan administrator, one who will allow you to invest in the vehicles you wish to invest in.

Which plan administrator is right?

There are at least four areas we need to question when choosing a plan administrator. All areas are equally important because of the impact on the growth of your retirement funds. The few hours necessary to research, review, and resolve the administrator issue for the health of your retirement plan will be well spent.

1st: Flexibility

Determine what it is you want to do with your IRA funds. If you have all of the retirement funds you need, you do not need the flexibility of a self-directed account. Instead, you can use any one of the many directed plans now being offered by a multitude of banks, S & Ls, credit unions, and brokerages.

If, on the other hand, you want your retirement funds to continue to grow and feel that you want some control over how investments are made, self-direction comes into play. You will want to choose an administrator with a plan that includes bank CDs, mutual funds, trust deeds, unsecured notes, annuities, treasuries, stocks (public and private), and real estate.

Real estate includes leveraged and all cash real estate, unimproved land, REITs, subdivisions, improved real estate, and limited partnerships (private and public). I can't wait to hear from the readers this month who'll be saying, "I didn't know you could do that."

2nd: Durability

Some companies succeed, some fail, some are marginally successful, and some are tremendously successful. How good is the administrator whose plan you will use?

Ask questions when interviewing for an administrator. When they don't answer the questions properly or refuse to provide a report, move on to the next one. You should be asking these types of questions:

• How long have they been in business?
• Are they bonded for theft and fraud?
• Who is their trustee or custodian?
• Do they have automatic sweeps of accounts?
• Do they have litigation ongoing or pending?
• Will they provide an audited annual report?

3rd: Ability

It is not the time to determine the ability of your administrator's staff after you've set up your self-directed account. While it will usually be your investment adviser's responsibility to deal with the representatives of the administrator on an ongoing basis, you need to pre-qualify their abilities.

Talk to the staff who handles the types of investments you intend to make. Since most of my client transactions deal with real estate, our investigation is directed at the staff who administers trust deeds, real estate, and limited partnerships. Questions we ask are:

• What is the turn around time on a standard trust deed purchase?
• What is the review process of limited partnerships?
• What are the most common problems in real estate transactions?

We also describe a proposed transaction and ask for input.

4th: Cost

Costs vary greatly from one administrator to another, and it is often difficult to understand the fees being charged. Each administrator uses a different format for fee schedules. They also use different names for similar fees. After all, why call an apple an apple when you can call it a red fruit with a crisp white center?

On a computer model we recently compared six different administrators. Each were compared for one year with an asset base of $100,000 and four identical transactions. The fees charged in the test year by the administrators ran from $285 to $1,362.

There are really two basic types of administrators: fee-based and asset-based. The fee-based charge for each transaction is on a flat fee basis. The asset-based charge is a percentage of the gross asset. There is also a hybrid that uses a combination of asset and fee-based schedules.

In addition we found that the yardstick keeps moving when trying to compare fees for services. The frequency of transactions and the asset value of the account weigh greatly on the expense of the account. I might point out that even the highest priced administrator was fairly reasonable. It is just a matter of cost containment.

Also, remember that reasonable costs to run the IRA accounts are deductible in the year incurred, therefore, don't make the mistake of paying the fees out of you account or you are losing out on an additional deduction.

In closing, let me suggest a few more questions to ask your prospective new administrator.

• Are they independent of product?
• Do they provide timely accounting?
• Are their charges asset or fee based?
• Do they charge for termination?
• Are they accessible for complaints?
• What do others have to say about them?

IRAs are meant to be flexible retirement accounts that the average person can direct into the areas of their choice. How it changed from that into direction by others, I'll leave you to speculate about. You can invest in almost any investment vehicle you wish -- you just need to have your assets with a plan that allows it.

Copyright © 2006 by Patrick W. Rice